[Federal Register Volume 75, Number 85 (Tuesday, May 4, 2010)]
[Notices]
[Pages 23718-23728]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-10313]
-----------------------------------------------------------------------
COMMODITY FUTURES TRADING COMMISSION
Orders Finding That the Henry Financial Basis Contract, Henry
Financial Index Contract and Henry Financial Swing Contract Traded on
the IntercontinentalExchange, Inc., Do Not Perform a Significant Price
Discovery Function
AGENCY: Commodity Futures Trading Commission.
ACTION: Final orders.
-----------------------------------------------------------------------
SUMMARY: On October 20, 2009, the Commodity Futures Trading Commission
(``CFTC'' or ``Commission'') published for comment in the Federal
Register \1\ a notice of its intent to undertake a determination
whether the Henry Financial Basis (``HEN'') contract, Henry Financial
Index (``HIS'') contract and Henry Financial Swing (``HHD'') contract
traded on the IntercontinentalExchange, Inc. (``ICE''), an exempt
commercial market (``ECM'') under sections 2(h)(3)-(5) of the Commodity
Exchange Act (``CEA'' or the ``Act''), perform a significant price
discovery function pursuant to section 2(h)(7) of the CEA. The
Commission undertook this review based upon an initial evaluation of
information and data provided by ICE as well as other available
information. The Commission has reviewed the entire record in this
matter, including all comments received, and has determined to issue
orders finding that the HEN, HIS and HHD contracts do not perform a
significant price discovery function. Authority for this action is
found in section 2(h)(7) of the CEA and Commission rule 36.3(c)
promulgated thereunder.
---------------------------------------------------------------------------
\1\ 74 FR 53720 (October 20, 2009).
---------------------------------------------------------------------------
DATES: Effective date: April 28, 2010.
FOR FURTHER INFORMATION CONTACT: Gregory K. Price, Industry Economist,
Division of Market Oversight, Commodity Futures Trading Commission,
Three Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581.
Telephone: (202) 418-5515. E-mail: [email protected]; or Susan Nathan,
Senior Special Counsel, Division of Market Oversight, same address.
Telephone: (202) 418-5133. E-mail: [email protected].
SUPPLEMENTARY INFORMATION:
I. Introduction
The CFTC Reauthorization Act of 2008 (``Reauthorization Act'') \2\
significantly broadened the CFTC's regulatory authority with respect to
ECMs by creating, in section 2(h)(7) of the CEA, a new regulatory
category--ECMs on which significant price discovery contracts
(``SPDCs'') are traded--and treating ECMs in that category as
registered entities under the CEA.\3\ The legislation authorizes the
CFTC to designate an agreement, contract or transaction as a SPDC if
the Commission determines, under criteria established in section
2(h)(7), that it performs a significant price discovery function. When
the Commission makes such a determination, the ECM on which the SPDC is
traded must assume, with respect to that contract, all the
responsibilities and obligations of a registered entity under the Act
and Commission regulations, and must comply with nine core principles
established by new section 2(h)(7)(C).
---------------------------------------------------------------------------
\2\ Incorporated as Title XIII of the Food, Conservation and
Energy Act of 2008, Pub. L. 110-246, 122 Stat. 1624 (June 18, 2008).
\3\ 7 U.S.C. 1a(29).
---------------------------------------------------------------------------
On March 16, 2009, the CFTC promulgated final rules implementing
the provisions of the Reauthorization Act.\4\ As relevant here, rule
36.3 imposes increased information reporting requirements on ECMs to
assist the Commission in making prompt assessments whether particular
ECM contracts may be SPDCs. In addition to filing quarterly reports of
its contracts, an ECM must notify the Commission promptly concerning
any contract traded in reliance on the exemption in section 2(h)(3) of
the CEA that averaged
[[Page 23719]]
five trades per day or more over the most recent calendar quarter, and
for which the exchange sells its price information regarding the
contract to market participants or industry publications, or whose
daily closing or settlement prices on 95 percent or more of the days in
the most recent quarter were within 2.5 percent of the
contemporaneously determined closing, settlement or other daily price
of another contract.
---------------------------------------------------------------------------
\4\ 74 FR 12178 (Mar. 23, 2009); these rules became effective on
April 22, 2009.
---------------------------------------------------------------------------
Commission rule 36.3(c)(3) established the procedures by which the
Commission makes and announces its determination whether a particular
ECM contract serves a significant price discovery function. Under those
procedures, the Commission will publish notice in the Federal Register
that it intends to undertake an evaluation whether the specified
agreement, contract or transaction performs a significant price
discovery function and to receive written views, data and arguments
relevant to its determination from the ECM and other interested
persons. Upon the close of the comment period, the Commission will
consider, among other things, all relevant information regarding the
subject contract and issue an order announcing and explaining its
determination whether or not the contract is a SPDC. The issuance of an
affirmative order signals the effectiveness of the Commission's
regulatory authorities over an ECM with respect to a SPDC; at that time
such an ECM becomes subject to all provisions of the CEA applicable to
registered entities.\5\ The issuance of such an order also triggers the
obligations, requirements and timetables prescribed in Commission rule
36.3(c)(4).\6\
---------------------------------------------------------------------------
\5\ Public Law 110-246 at 13203; Joint Explanatory Statement of
the Committee of Conference, H.R. Rep. No. 110-627, 110 Cong., 2d
Sess. 978, 986 (Conference Committee Report). See also 73 FR 75888,
75894 (Dec. 12, 2008).
\6\ For an initial SPDC, ECMs have a grace period of 90 calendar
days from the issuance of a SPDC determination order to submit a
written demonstration of compliance with the applicable core
principles. For subsequent SPDCs, ECMs have a grace period of 30
calendar days to demonstrate core principle compliance.
---------------------------------------------------------------------------
II. Notice of Intent To Undertake SPDC Determination
On October 20, 2009, the Commission published in the Federal
Register notice of its intent to undertake a determination whether the
HEN, HIS and HHD contracts performs a significant price discovery
function and requested comment from interested parties.\7\ Comments \8\
were received from the Federal Energy Regulatory Commission (``FERC''),
Platts,\9\ Public Utility Commission of Texas (``PUCT'') and ICE. The
comment letters from FERC,\10\ Platts and PUCT \11\ did not directly
address the issue of whether or not the HEN, HIS and HHD contracts are
SPDCs; ICE's comments raised substantive issues with respect to the
applicability of section 2(h)(7) to the subject contracts. Generally,
ICE asserted that its HEN, HIS and HHD contracts are not SPDCs as they
do not meet any of the criteria for SPDC determination (CL 03). ICE's
comments are more extensively discussed below, as applicable.
---------------------------------------------------------------------------
\7\ The Commission's Part 36 rules establish, among other
things, procedures by which the Commission makes and announces its
determination whether a specific ECM contract serves a significant
price discovery function. Under those procedures, the Commission
publishes a notice in the Federal Register that it intends to
undertake a determination whether a specified agreement, contract or
transaction performs a significant price discovery function and to
receive written data, views and arguments relevant to its
determination from the ECM and other interested persons.
\8\ The comment letters are available on the Commission's Web
site: http://www.cftc.gov/lawandregulation/federalregister/federalregistercomments/2009/09-027.html.
\9\ McGraw-Hill, through its division Platts, compiles and
calculates monthly natural gas price indices from natural gas trade
data submitted to Platts by energy marketers. Platts includes those
price indices in its monthly Inside FERC's Gas Market Report
(``Inside FERC'').
\10\ FERC stated that the HEN, HIS and HHD contracts are cash-
settled and that none of them contemplates the actual physical
delivery of natural gas. Accordingly, FERC expressed the opinion
that a determination by the Commission that a contract performs a
significant price discovery function ``would not appear to conflict
with FERC's exclusive jurisdiction under the Natural Gas Act (NGA)
over certain sales of natural gas in interstate commerce for resale
or with its other regulatory responsibilities under the NGA'' and
further that ``FERC staff will continue to monitor for any such
conflict * * * [and] advise the CFTC'' should any such potential
conflict arise. CL 01.
\11\ PUCT noted that it oversees the Electric Reliability
Council of Texas, much like FERC oversees independent system
operators. The mission of PUCT is ``to ensure nondiscriminatory
access to the [electricity] transmission and distribution systems,
to ensure the reliability and adequacy of the regional electrical
network and to perform other essential market functions.'' CL 04.
---------------------------------------------------------------------------
III. Section 2(h)(7) of the CEA
The Commission is directed by section 2(h)(7) of the CEA to
consider the following criteria in determining a contract's significant
price discovery function:
Price Linkage--the extent to which the agreement, contract
or transaction uses or otherwise relies on a daily or final settlement
price, or other major price parameter, of a contract or contracts
listed for trading on or subject to the rules of a designated contract
market (``DCM'') or derivatives transaction execution facility
(``DTEF''), or a SPDC traded on an electronic trading facility, to
value a position, transfer or convert a position, cash or financially
settle a position, or close out a position.
Arbitrage--the extent to which the price for the
agreement, contract or transaction is sufficiently related to the price
of a contract or contracts listed for trading on or subject to the
rules of a DCM or DTEF, or a SPDC traded on or subject to the rules of
an electronic trading facility, so as to permit market participants to
effectively arbitrage between the markets by simultaneously maintaining
positions or executing trades in the contracts on a frequent and
recurring basis.
Material price reference--the extent to which, on a
frequent and recurring basis, bids, offers or transactions in a
commodity are directly based on, or are determined by referencing or
consulting, the prices generated by agreements, contracts or
transactions being traded or executed on the electronic trading
facility.
Material liquidity--the extent to which the volume of
agreements, contracts or transactions in a commodity being traded on
the electronic trading facility is sufficient to have a material effect
on other agreements, contracts or transactions listed for trading on or
subject to the rules of a DCM, DTEF or electronic trading facility
operating in reliance on the exemption in section 2(h)(3).
Not all criteria must be present to support a determination that a
particular contract performs a significant price discovery function,
and one or more criteria may be inapplicable to a particular
contract.\12\ Moreover, the statutory language neither prioritizes the
criteria nor specifies the degree to which a SPDC must conform to the
various criteria. In Guidance issued in connection with the Part 36
rules governing ECMs with SPDCs, the
[[Page 23720]]
Commission observed that these criteria do not lend themselves to a
mechanical checklist or formulaic analysis. Accordingly, the Commission
has indicated that in making its determinations it will consider the
circumstances under which the presence of a particular criterion, or
combination of criteria, would be sufficient to support a SPDC
determination.\13\ For example, for contracts that are linked to other
contracts or that may be arbitraged with other contracts, the
Commission will consider whether the price of the potential SPDC moves
in such harmony with the other contract that the two markets
essentially become interchangeable. This co-movement of prices would be
an indication that activity in the contract had reached a level
sufficient for the contract to perform a significant price discovery
function. In evaluating a contract's price discovery role as a price
reference, the Commission will consider whether cash market
participants are quoting bid or offer prices or entering into
transactions at prices that are set either explicitly or implicitly at
a differential to prices established for the contract.
---------------------------------------------------------------------------
\12\ In its October 20, 2009, Federal Register release, the
Commission identified material liquidity, material price reference
and price linkage as the possible criteria for SPDC determination of
the HEN contract (arbitrage was not identified as a possible
criterion). With respect to the HIS contract, the Federal Register
release identified material liquidity and material price reference
as possible criteria for SPDC determination (price linkage and
arbitrage were not identified as possible criteria). With respect to
the HHD contract, the Federal Register release identified material
liquidity, arbitrage and material price reference as possible
criteria for SPDC determination (price linkage was not identified as
a possible criterion). The criteria not indentified in the initial
release will not be discussed further in this document or the
associated Orders.
\13\ 17 CFR part 36, Appendix A.
---------------------------------------------------------------------------
IV. Findings and Conclusions
The Commission's findings and conclusions with respect to the Henry
Financial Basis (HEN) contract, the Henry Financial Index (HIS)
contract and the Henry Financial Swing (HHD) contract are discussed
separately below.
a. The Henry Financial Basis (HEN) Contract and the SPDC Indicia
The ICE HEN contract is cash settled based on the difference
between the bidweek price of natural gas at the Henry Hub for the
contract-specified month of delivery, as reported in Platts' Inside
FERC's Gas Market Report, and the final settlement price for New York
Mercantile Exchange's (``NYMEX's'') Henry Hub physically-delivered
natural gas futures contract for the same specified calendar month. The
Platts bidweek price, which is published monthly, is based on a survey
of cash market traders who voluntarily report to Platts data on their
fixed-price transactions conducted during the last five business days
of the month for physical delivery of natural gas at the Henry Hub;
such bidweek transactions specify the delivery of natural gas on a
uniform basis throughout the following calendar month at the agreed
upon rate. The Platts bidweek index is published on the first business
day of the calendar month in which the natural gas is to be delivered.
The size of the HEN contract is 2,500 million British thermal units
(``mmBtu''), and the unit of trading is any multiple of 2,500 mmBtu.
The HEN contract is listed for up to 72 calendar months commencing with
the next calendar month.
The Henry Hub,\14\ which is located in Erath, Louisiana, is the
primary cash market trading and distribution center for natural gas in
the United States. It also is the delivery point and pricing basis for
the NYMEX's actively traded Henry Hub physically-delivered natural gas
futures contract, which is the most important pricing reference for
natural gas in the United States. The Henry Hub, which is operated by
Sabine Pipe Line, LLC, serves as a juncture for 13 different pipelines.
These pipelines bring in natural gas from fields in the Gulf Coast
region and move it to major consumption centers along the East Coast
and Midwest. The throughput shipping capacity of the Henry Hub is 1.8
trillion mmBtu per day.
---------------------------------------------------------------------------
\14\ The term ``hub'' refers to a juncture where two or more
natural gas pipelines are connected. Hubs also serve as pricing
points for natural gas.
---------------------------------------------------------------------------
The HEN contract price measures the discrepancy between two Henry
Hub-related prices, where one price is a futures price and the other is
a forward cash price. Traders may make commitments to buy or sell
natural gas at the Henry Hub using the NYMEX Henry Hub natural gas
futures contract, which specifies physical delivery. Because the NYMEX
futures contract is listed for at least twelve years, market
participants can make such decisions a long time before delivery
actually occurs, since they can have an effective hedge in place to
offset price risk associated with long-dated cash market commitments.
While the futures price and the bidweek price both reflect the price of
natural gas during the following month, the two values may not be
equal. This is because the NYMEX futures contract stops trading three
business days prior to first business day of the delivery month. In
contrast, the bidweek price is derived from cash market deals
consummated during the last five business days of the month that
specify physical delivery during the following calendar month. Thus, it
is possible that the bidweek price could include two additional days of
market information, which could result in a price that is significantly
higher or lower than the futures price. The ICE HEN contract can be
used to more accurately price natural gas in the delivery month. For
example, a firm may lock in its November 2009 needs by taking a long
position in the November 2009 contract. Assume that the futures
position is established at $4.00 per mmBtu. This means that the gas was
purchased at $4, which may be higher or lower than the spot price
during the delivery month. During the final few days in October, the
November 2009 natural gas contract stops trading and the November
bidweek price is determined. Assume that the weather forecast calls for
warmer than normal temperatures in the area, causing the futures price
to fall and settle on October 27 at $3.90 per mmBtu, resulting in a
loss of $0.10 per mmBtu on the futures side. Market sentiment of a
strong downward pressure on gas prices may persist, leading spot
transactions for next-month delivery to be priced even lower than the
futures settlement price. In this regard, the bidweek price is
determined as a volume weighted average of fixed-price transactions for
November 2009 delivery that were conducted between October 25, 2009,
and October 29, 2009. If the bidweek price ends up being at $3.75 per
mmBtu, the firm will incur an additional loss of $0.15 per mmBtu
because of falling spot prices. By taking a position in the ICE HEN
contract, the firm can mitigate some of the losses by accounting for
the difference between the final settlement price and the bidweek
price.\15\
---------------------------------------------------------------------------
\15\ If the firm simultaneously takes positions involving the
NYMEX futures contract and the ICE HEN basis contract, the firm will
be able to price the natural gas at the bidweek price.
---------------------------------------------------------------------------
In its October 20, 2009, Federal Register notice, the Commission
identified material liquidity, price linkage and material price
reference as the potential SPDC criteria applicable to the HEN
contract. Each of these criteria is discussed below.\16\
---------------------------------------------------------------------------
\16\ As noted above, the Commission did not find an indication
of arbitrage in connection with this contract; accordingly, that
criterion is not discussed in reference to the HEN contract.
---------------------------------------------------------------------------
1. Material Price Reference Criterion
The Commission's October 20, 2009, Federal Register notice
identified material price reference as a potential basis for a SPDC
determination with respect to this contract. The Commission noted that
ICE sells its price data to market participants in a number of
different packages which vary in terms of the hubs covered, time
periods and whether the data are daily only or historical. For example,
ICE offers the ``Gulf Gas End of Day'' and ``OTC Gas End of Day'' \17\
packages with access to all price data or just current prices plus a
selected number of months (i.e., 12, 24, 36 or 48 months) of
[[Page 23721]]
historical data. These two packages include price data for the HEN
contract.
---------------------------------------------------------------------------
\17\ The OTC Gas End of Day dataset includes daily settlement
prices for natural gas contracts listed for all points in North
America.
---------------------------------------------------------------------------
Although the Henry Hub is a major trading center for natural gas in
the United States and, as noted, ICE sells price information for the
HEN contract, the Commission has found upon further evaluation that the
HEN contract is not routinely consulted by industry participants in
pricing cash market transactions and thus does not meet the
Commission's Guidance for the material price reference criterion. In
this regard, the NYMEX Henry Hub physically delivered natural gas
futures contract is routinely consulted by industry participants in
pricing cash market transactions at this location. Because both the HEN
and the NYMEX contracts basically price the same commodity at the same
location and time and the NYMEX contract has significantly higher
trading volume and open interest,\18\ it is not necessary for market
participants to independently refer to the HEN contract for pricing
natural gas at this location. Furthermore, the Commission notes that
publication of the HEN contract's prices is not indirect evidence of
routine dissemination. The HEN contract's prices are published with
those of numerous other contracts, which are of more interest to market
participants.\19\ The Commission cannot surmise whether or not traders
specifically purchase the ICE data packages for the HEN contract's
prices.
---------------------------------------------------------------------------
\18\ Trading data was obtained by the Commission using the
Integrated Surveillance System.
\19\ The Commission will rely on one of two sources of
evidence--direct or indirect--to determine a SPDC. Direct evidence
can be cash market transactions that are frequently based on or
quoted as a differential to the potential SPDC. Indirect evidence
includes contracts whose price series are routinely disseminated in
industry publications or are sold to market participants by the ECM.
---------------------------------------------------------------------------
i. Federal Register Comments
As noted above, ICE was the sole respondent which addressed the
question of whether the HEN contract is a SPDC. ICE stated in its
comment letter that the HEN contract does not meet the material price
reference criterion for SPDC determination. ICE stated that the
Commission appeared to base the case that the HEN contract is
potentially a SPDC on a disputable assertion. In issuing its notice of
intent to determine whether the HEN contract is a SPDC, the CFTC cited
a general conclusion in its ECM study ``that certain market
participants referred to ICE as a price discovery market for certain
natural gas contracts.'' ICE states that ``[b]asing a material price
reference determination on general statements made in a two year old
study does not seem to meet Congress' intent that the CFTC use its
considerable expertise to study the OTC markets.'' The Commission cited
the ECM study's general finding that some ICE natural gas contracts
appear to be regarded as price discovery markets as an indication that
an investigation of certain ICE contracts may be warranted; the ECM
study was not intended to serve as the sole basis for determining
whether or not a particular contract meets the material price reference
criterion.
ii. Conclusion Regarding Material Price Reference
The Commission finds that the HEN contract does not meet the
material price reference criterion because it is not routinely
consulted by cash market participants when pricing transactions at the
Henry Hub (direct evidence is not supported). Moreover, the ECM sells
the HEN contract's price data along with those of other contracts,
which are of more interest to market participants (indirect evidence is
not supported).
2. Price Linkage Criterion
In its October 20, 2009, Federal Register notice, the Commission
identified price linkage as a potential basis for a SPDC determination
with respect to the HEN contract. In this regard, the final settlement
of the HEN contract is based, in part, on the final settlement price of
the NYMEX's Henry Hub physically-delivered natural gas futures
contract, where the NYMEX is registered with the Commission as a DCM.
The Commission's Guidance on Significant Price Discovery Contracts
\20\ notes that a ``price-linked contract is a contract that relies on
a contract traded on another trading facility to settle, value or
otherwise offset the price-linked contract.'' Furthermore, the Guidance
notes that ``[f]or a linked contract, the mere fact that a contract is
linked to another contract will not be sufficient to support a
determination that a contract performs a significant price discovery
function. To assess whether such a determination is warranted, the
Commission will examine the relationship between transaction prices of
the linked contract and the prices of the referenced contract. The
Commission believes that where material liquidity exists, prices for
the linked contract would be observed to be substantially the same as,
or move substantially in conjunction with, the prices of the referenced
contract.'' The Guidance proposes a threshold price relationship such
that prices of the ECM linked contract will fall within a 2.5 percent
price range for 95 percent of contemporaneously determined closing,
settlement or other daily prices over the most recent quarter. Finally,
the Commission also stated in the Guidance that it would consider a
linked contract that has a trading volume equivalent to 5 percent of
the volume of trading in the contract to which it is linked to have
sufficient volume potentially to be deemed a SPDC (``minimum
threshold'').
---------------------------------------------------------------------------
\20\ Appendix A to the Part 36 rules.
---------------------------------------------------------------------------
To assess whether the HEN contract meets the price linkage
criterion, Commission staff obtained price data from ICE and performed
the statistical tests cited above. Staff found that the Henry Hub
futures/cash price differential is determined in part by the final
settlement price of the NYMEX Henry Hub physically-delivered natural
gas futures contract (a DCM contract) and that the derived Henry Hub
prices (using the NYMEX Henry Hub natural gas futures contract's
settlement prices and the Henry Hub cash price differentials) are
within 2.5 percent of the settlement prices of the corresponding NYMEX
Henry Hub natural gas futures contract on 95 percent or more of the
days. Specifically, during the third quarter of 2009, 100 percent of
the Henry Hub natural gas prices derived from the HEN values were
within 2.5 percent of the daily settlement price of NYMEX Henry Hub
natural gas futures contract. However, staff found that the HEN
contract fails to meet the volume threshold requirement. In particular,
the total trading volume in the NYMEX Henry Hub natural gas futures
contract during the third quarter of 2009 was 14,022,963 contracts,
with 5 percent of that number being 701,148 contracts. The number of
trades on the ICE centralized market in the HEN contract during the
same period totaled 173,973 contracts (equivalent to 43,493 NYMEX
futures contracts, given the size difference).\21\ Thus, total amount
of centralized-market trades in the HEN contract was significantly
below the minimum threshold.
---------------------------------------------------------------------------
\21\ The HEN contract is one-quarter the size of the NYMEX Henry
Hub physically-delivered futures contract.
---------------------------------------------------------------------------
i. Federal Register Comments
ICE was the sole respondent which addressed the question of whether
the HEN contract is a SPDC. ICE stated in its comment letter that the
HEN contract does not meet the price linkage criterion for SPDC
determination because it fails the volume test provided in the
Commission's Guidance.
[[Page 23722]]
ii. Conclusion Regarding the Price Linkage Criterion
The Commission finds that the HEN contract does not meet the price
linkage criterion because it fails the volume test provided for in the
Commission's Guidance.
3. Material Liquidity Criterion
As noted above, in its October 20, 2009, Federal Register notice,
the Commission identified material liquidity, price linkage and
material price reference as potential criteria for SPDC determination
of the HEN contract. With respect to the material liquidity criterion,
the Commission noted that the total number of transactions executed on
ICE's electronic platform in the HEN contract was 538 in the second
quarter of 2009, resulting in a daily average of 8.4 trades. During the
same period, the HEN contract had a total trading volume of 78,780
contracts and an average daily trading volume of 1,232 contracts.
Moreover, open interest as of June 30, 2009, was 128,504 contracts,
which included trades executed on ICE's electronic trading platform, as
well as trades executed off of ICE's electronic trading platform and
then brought to ICE for clearing. In this regard, ICE does not
differentiate between open interest created by a transaction executed
on its trading platform and that created by a transaction executed off
its trading platform.\22\ In a subsequent filing dated November 13,
2009, ICE reported that total trading volume in the third quarter of
2009 was 173,973 contracts (or 2,636 contracts on a daily basis). In
term of number of transactions, 1,174 trades occurred in the third
quarter of 2009 (17.8 trades per day). As of September 30, 2009, open
interest in the HEN contract was 160,804 contracts, which included
trades executed on ICE's electronic trading platform, as well as trades
executed off of ICE's electronic trading platform and then brought to
ICE for clearing.
---------------------------------------------------------------------------
\22\ 74 FR 53720 (October 20, 2009).
---------------------------------------------------------------------------
The Commission notes that trading activity in the HEN contract
increased between the second and third quarters of 2009. However, the
number of trades per day remained relatively low and only slightly more
than the reporting level of five trades per day. Moreover, the
Commission notes that the number of contracts traded is comparable to
that experienced in a relatively small futures market, such as the
NYMEX Platinum and ICE US Frozen Concentrated Orange Juice contracts.
Accordingly, the data at best provides weak evidence that the HEN
contract meets the material liquidity criterion.\23\
---------------------------------------------------------------------------
\23\ In establishing guidance to illustrate how it will evaluate
the various criteria, or combinations of criteria, when determining
whether a contract is a SPDC, the Commission made clear that
``material liquidity itself would not be sufficient to make a
determination that a contract is a [SPDC], * * * but combined with
other factors it can serve as a guidepost indicating which contracts
are functioning as [SPDCs].'' For the reasons discussed above, the
Commission has found that the HEN contract does not meet either the
price linkage or material price reference criterion. In light of
this finding and the Commission's Guidance cited above, there is no
need to evaluate further the material liquidity criteria since it
cannot be used alone as a basis for a SPDC determination.
---------------------------------------------------------------------------
i. Federal Register Comments
As noted above, ICE was the sole respondent which addressed the
question of whether the HEN contract is a SPDC. ICE stated in its
comment letter that the HEN contract does not meet the material
liquidity criterion for SPDC determination for a number of reasons.
First, ICE opined that the Commission ``seems to have adopted a
five trade-per-day test to determine whether a contract is materially
liquid. It is worth noting that ICE originally suggested that the CFTC
use a five trades-per-day threshold as the basis for an ECM to report
trade data to the CFTC.'' On the contrary, the Commission adopted a
five trades-per-day threshold as a reporting requirement to enable it
to ``independently be aware of ECM contracts that may develop into
SPDCs'' \24\ rather than solely relying upon an ECM on its own to
identify any such potential SPDCs to the Commission. While a contract
that meets this threshold may be subject to scrutiny as a potential
SPDC, the threshold is not a test for material liquidity. As noted
above, the Commission has not reached a decision regarding material
liquidity because, regardless of the relatively large quarterly trading
volume in the HEN contract, material liquidity alone is not sufficient
to support a SPDC determination.
---------------------------------------------------------------------------
\24\ 73 FR 75892 (December 12, 2008).
---------------------------------------------------------------------------
ICE also stated that ``the statistics [provided by ICE] have been
misinterpreted and misapplied.'' In particular, ICE stated that the
volume figures used in the Commission's analysis (cited above)
``include trades made in all 120 months of each contract'' as well as
in strips of contract months, and a ``more appropriate method of
determining liquidity is to examine the activity in a single traded
month or strip of a given contract.'' Furthermore, ICE noted that for
the HEN contract, ``98% of the trades and volume actually executed on
the ICE platform occurred in the single most liquid, usually prompt,
month of the contract.''
It is the Commission's opinion that liquidity, as it relates to the
HEN contract, is typically a function of trading activity in particular
lead months and, given sufficient liquidity in such months, the HEN
contract itself would be considered liquid. ICE's analysis of its own
trade data confirms this to be the case for the HEN contract, and thus,
the Commission believes that it applied the statistical data cited
above in an appropriate manner for gauging material liquidity.
In addition, ICE stated that the trades-per-day statistics that it
provided to the Commission in its quarterly filing and which are cited
above includes 2(h)(1) transactions, which were not completed on the
electronic trading platform and should not be considered in the SPDC
determination process. Commission staff asked ICE to review the data it
sent in its quarterly filings. In response, ICE confirmed that the
volume data it provided and which the Commission cited in its October
20, 2009, Federal Register notice, as well as the additional volume
information it cites above, includes only transaction data executed on
ICE's electronic trading platform.\25\ The Commission acknowledges that
the open interest information it cites above includes transactions made
off the ICE platform. However, once open interest is created, there is
no way for ICE to differentiate between ``on-exchange'' versus ``off-
exchange'' created positions, and all such positions are fungible with
one another and may be offset in any way agreeable to the position
holder regardless of how the position was initially created.
---------------------------------------------------------------------------
\25\ Supplemental data supplied by ICE confirmed that block
trades in the third quarter of 2009 were in addition to the trades
that were conducted on the electronic platform; block trades
comprised 62.2 percent of all transactions in the HEN contract.
---------------------------------------------------------------------------
ii. Conclusion Regarding Material Liquidity
For the reasons discussed above, the Commission finds at best weak
evidence that the HEN contract meets the material liquidity criterion.
However, because the HEN contract does not meet either the price
linkage or material price reference criterion, it is not possible to
declare the HEN contract a SPDC since material liquidity cannot be used
alone as a basis for a SPDC determination.
4. Overall Conclusion the HEN Contract
After considering the entire record in this matter, including the
comments received, the Commission has determined that the HEN contract
does not perform a significant price discovery
[[Page 23723]]
function under the criteria established in section 2(h)(7) of the CEA.
Specifically, the Commission has determined that the HEN contract does
not meet the material price reference and price linkage criteria at
this time, and there is at best weak evidence that it meets the
material liquidity criterion, which is not sufficient by itself to
support a SPDC determination. Accordingly, the Commission will issue
the attached Order declaring that the HEN contract is not a SPDC.
Issuance of this Order indicates that the Commission does not at
this time regard ICE as a registered entity in connection with its HEN
contract.\26\ Accordingly, with respect to its HEN contract, ICE is not
required to comply with the obligations, requirements and timetables
prescribed in Commission rule 36.3(c)(4) for ECMs with SPDCs.
---------------------------------------------------------------------------
\26\ See 73 FR 75888, 75893 (Dec. 12, 2008).
---------------------------------------------------------------------------
b. The Henry Financial Index (HIS) Contract and the SPDC Indicia
The ICE HIS contract is cash settled based on the arithmetic
average of the daily natural gas prices at the Henry Hub, as quoted in
the ``Daily Price Survey'' table of Platts' Gas Daily during the
specified month, less the Platts bidweek price that is reported in the
first issue of Inside FERC's Gas Market Report in which the natural gas
is delivered. The Platts prices are based on the fixed-price cash
market transactions that are voluntarily reported by traders. As noted
above, the Platts bidweek price is based on a survey of cash market
traders who voluntarily report data on their fixed-price transactions
conducted during the last five business days of the month for physical
delivery of natural gas at the Henry Hub on a uniform basis throughout
the following calendar month. The Platts bidweek index is published on
the first business day of the calendar month in which the natural gas
is to be delivered. The Gas Daily price is for next-day delivery of
natural gas at the Henry Hub. The size of the HIS contract is 2,500
mmBtu, and the unit of trading is any multiple of 2,500 mmBtu. The HIS
contract is listed for 36 calendar months.
The index used to settle the HIS contract measures the discrepancy
between two cash market prices for natural gas, where one (the Platts
bidweek price) is a fixed forward price that locks in the price paid
for gas deliveries made on each calendar day of the following month.
The other price (the Platts Daily Price Survey) is a calendar month
average of the daily spot price for gas deliveries made during the same
month. The forward and average spot prices may differ from each other
as new market conditions unfold during the month in which deliveries
are made.
For example, assume that a firm prices natural gas that is going to
be delivered at the Henry Hub in November 2009 at the bidweek price.
The NYMEX Henry Hub futures can be used to procure the physical gas,
and HEN contract can be overlayed in order to achieve the bidweek
price. If there is a potential that the average daily price during the
delivery month may differ from the bidweek price, the firm can add the
HIS contract to the NYMEX futures/ICE HEN combination to achieve a
price that is based on actual daily prices rather than a forward spot
price that applies to all business days in the delivery month. As a
result, the HIS contract allows commercial participants to price
natural gas more accurately during the delivery period.
In its October 20, 2009, Federal Register notice, the Commission
identified material liquidity and material price reference as the
potential SPDC criteria applicable to the HIS contract. Each of these
factors is discussed below.\27\
---------------------------------------------------------------------------
\27\ As noted above, the Commission did not find an indication
of arbitrage and price linkage in connection with this contract;
accordingly, those criteria are not discussed in reference to the
HIS contract.
---------------------------------------------------------------------------
1. Material Price Reference Criterion
The Commission's October 20, 2009, Federal Register notice
identified material price reference as a potential basis for a SPDC
determination with respect to this contract. The Commission noted that
ICE sells its price data to market participants in a number of
different packages which vary in terms of the hubs covered, time
periods, and whether the data are daily only or historical. For
example, ICE offers ``Gulf Gas End of Day'' and ``OTC Gas End of Day''
\28\ with access to all price data or just current prices plus a
selected number of months (i.e., 12, 24, 36 or 48 months) of historical
data. These two packages include price data for the HIS contract.
---------------------------------------------------------------------------
\28\ The OTC Gas End of Day dataset includes daily settlement
prices for natural gas contracts listed for all points in North
America.
---------------------------------------------------------------------------
Although the Henry Hub is a major trading center for natural gas in
the United States, and as noted ICE does sell price information for the
HIS contract, the Commission has found upon further evaluation that the
HIS contract is not ``routinely consulted by industry participants in
pricing cash market transactions'' and thus does not meet the
Commission's guidance for the material price reference criterion. In
this regard, the NYMEX Henry Hub natural gas futures contract is
routinely consulted by industry participants in pricing cash market
transactions at this location. Because both the HIS and the NYMEX
contracts basically price the same commodity at the same location and
time and the NYMEX futures contract has significantly higher trading
volume and open interest, it is not necessary for market participants
to independently refer to the HIS contract for pricing natural gas at
this location. Furthermore, the Commission notes that publication of
the HIS contract's prices is not indirect evidence of routine
dissemination. The HIS contract's prices are published with those of
numerous other contracts, which are of more interest to market
participants.\29\ The Commission cannot surmise whether or not traders
specifically purchase the ICE data packages for the HIS contract's
prices.
---------------------------------------------------------------------------
\29\ The Commission will rely on one of two sources of
evidence--direct or indirect--to determine a SPDC. Direct evidence
can be cash market transactions that are frequently based on or
quoted as a differential to the potential SPDC. Indirect evidence
includes contracts whose price series are routinely disseminated in
industry publications or are sold to market participants by the ECM.
---------------------------------------------------------------------------
i. Federal Register Comments
As noted above, ICE was the sole respondent which addressed the
question of whether the HIS contract is a SPDC. ICE stated in its
comment letter that the HIS contract does not meet the material price
reference criterion for SPDC determination and, further, that the
Commission's identification of the HIS contract as a potential SPDC is
based on a disputable assertion. In issuing its notice of intent to
determine whether the HIS contract is a SPDC, the CFTC cited a general
conclusion in its ECM study ``that certain market participants referred
to ICE as a price discovery market for certain natural gas contracts.''
ICE states that ``[b]asing a material price reference determination on
general statements made in a two year old study does not seem to meet
Congress' intent that the CFTC use its considerable expertise to study
the OTC markets.'' The Commission cited the ECM study's general finding
that some ICE natural gas contracts appear to be regarded as price
discovery markets as an indication that an investigation of certain ICE
contracts may be warranted; the ECM study was not intended to serve as
the sole basis for determining whether or not a particular contract
meets the material price reference criterion.
[[Page 23724]]
ii. Conclusion Regarding Material Price Reference
The Commission finds that the HIS contract does not meet the
material price reference criterion because it is not routinely
consulted by cash market participants when pricing transactions at the
Henry Hub (direct evidence is not supported). Moreover, the ECM sells
the HIS contract's price data along with those of other contracts,
which are of more interest to market participants (indirect evidence is
not supported).
2. Material Liquidity Criterion
As noted above, in its October 20, 2009, Federal Register notice,
the Commission identified material liquidity and material price
reference as potential criteria for SPDC determination of the HIS
contract. With respect to the material liquidity criterion, the
Commission noted that the total number of transactions executed on
ICE's electronic platform in the HIS contract was 550 in the second
quarter of 2009, resulting in a daily average of 8.6 trades. During the
same period, the HIS contract had a total trading volume of 79,330
contracts and an average daily trading volume of 1,239 contracts.
Moreover, open interest as of June 30, 2009, was 127,346 contracts,
which included trades executed on ICE's electronic trading platform, as
well as trades executed off of ICE's electronic trading platform and
then brought to ICE for clearing. In this regard, ICE does not
differentiate between open interest created by a transaction executed
on its trading platform and that created by a transaction executed off
its trading platform.\30\ In a subsequent filing dated November 13,
2009, ICE reported that total trading volume in the third quarter of
2009 was 178,649 contracts (or 2,707 contracts on a daily basis). In
term of number of transactions, 1,250 trades occurred in the third
quarter of 2009 (18.9 trades per day). As of September 30, 2009, open
interest in the HIS contract was 255,496 contracts, which included
trades executed on ICE's electronic trading platform, as well as trades
executed off of ICE's electronic trading platform and then brought to
ICE for clearing.
---------------------------------------------------------------------------
\30\ 74 FR 53720 (October 20, 2009).
---------------------------------------------------------------------------
The Commission notes that trading activity in the HIS contract
increased between the second and third quarters of 2009. However, the
number of trades per day remained relatively low and only slightly more
than the reporting level of five trades per day. Moreover, the
Commission notes that the number of contracts traded is comparable to
that experienced in a relatively small futures market, such as the
NYMEX Platinum and ICE U.S. Frozen Concentrated Orange Juice contracts.
Accordingly, the data at best provides weak evidence that the HIS
contract meets the material liquidity criterion.\31\
---------------------------------------------------------------------------
\31\ In establishing guidance to illustrate how it will evaluate
the various criteria, or combinations of criteria, when determining
whether a contract is a SPDC, the Commission made clear that
``material liquidity itself would not be sufficient to make a
determination that a contract is a [SPDC], * * * but combined with
other factors it can serve as a guidepost indicating which contracts
are functioning as [SPDCs].'' For the reasons discussed above, the
Commission has found that the HIS contract does not meet either the
price linkage or material price reference criterion. In light of
this finding and the Commission's Guidance cited above, there is no
need to evaluate further the material liquidity criteria since it
cannot be used alone as a basis for a SPDC determination.
---------------------------------------------------------------------------
i. Federal Register Comments
As noted above, ICE was the sole respondent which addressed the
question of whether the HIS contract is a SPDC. ICE stated in its
comment letter that the HIS contract does not meet the material
liquidity criterion for SPDC determination for a number of reasons.
First, ICE opined that the Commission ``seems to have adopted a
five trade-per-day test to determine whether a contract is materially
liquid. It is worth noting that ICE originally suggested that the CFTC
use a five trades-per-day threshold as the basis for an ECM to report
trade data to the CFTC.'' On the contrary, the Commission adopted a
five trades-per-day threshold as a reporting requirement to enable it
to ``independently be aware of ECM contracts that may develop into
SPDCs'' \32\ rather than solely relying upon an ECM on its own to
identify any such potential SPDCs to the Commission. While a contract
that meets this threshold may be subject to scrutiny as a potential
SPDC, the threshold is not a test for material liquidity. As noted
above, the Commission has not reached a decision regarding material
liquidity because, regardless of the relatively large quarterly trading
volume in the HIS contract, material liquidity alone is not sufficient
to support a SPDC determination.
---------------------------------------------------------------------------
\32\ 73 FR 75892 (December 12, 2008).
---------------------------------------------------------------------------
ICE also stated that ``the statistics [provided by ICE] have been
misinterpreted and misapplied.'' In particular, ICE stated that the
volume figures used in the Commission's analysis (cited above)
``include trades made in all 120 months of each contract'' as well as
in strips of contract months, and a ``more appropriate method of
determining liquidity is to examine the activity in a single traded
month or strip of a given contract.'' Furthermore, ICE noted that for
the HIS contract, ``98% of the trades and volume actually executed on
the ICE platform occurred in the single most liquid, usually prompt,
month of the contract.''
It is the Commission's opinion that liquidity, with regard to the
HIS contract, is typically a function of trading activity in particular
lead months and, given sufficient liquidity in such months, the HIS
contract itself would be considered liquid. ICE's analysis of its own
trade data confirms this to be the case for the HIS contract, and thus,
the Commission believes that it applied the statistical data cited
above in an appropriate manner for gauging material liquidity.
In addition, ICE stated that the trades-per-day statistics that it
provided to the Commission in its quarterly filing and which are cited
above includes 2(h)(1) transactions, which were not completed on the
electronic trading platform and should not be considered in the SPDC
determination process. Commission staff asked ICE to review the data it
sent in its quarterly filings. In response, ICE confirmed that the
volume data it provided and which the Commission cited in its October
20, 2009, Federal Register notice as well as the additional volume
information it cites above includes only transaction data executed on
ICE's electronic trading platform.\33\ The Commission acknowledges that
the open interest information it cites above includes transactions made
off the ICE platform. However, once open interest is created, there is
no way for ICE to differentiate between ``on-exchange'' versus ``off-
exchange'' created positions, and all such positions are fungible with
one another and may be offset in any way agreeable to the position
holder regardless of how the position was initially created.
---------------------------------------------------------------------------
\33\ Supplemental data supplied by ICE confirmed that block
trades in the third quarter of 2009 were in addition to the trades
that were conducted on the electronic platform; block trades
comprised 59.7 percent of all transactions in the HIS contract.
---------------------------------------------------------------------------
ii. Conclusion Regarding Material Liquidity
For the reasons discussed above, the Commission finds weak evidence
at best that the HIS contract meets the material liquidity criterion.
However, because the HIS contract does not meet the material price
reference criterion, it is not possible to declare the HIS contract a
SPDC since material liquidity cannot be used alone as a basis for a
SPDC determination.
[[Page 23725]]
3. Overall Conclusion
After considering the entire record in this matter, including the
comments received, the Commission has determined that the HIS contract
does not perform a significant price discovery function under the
criteria established in section 2(h)(7) of the CEA. Specifically, the
Commission has determined that the HIS contract does not meet the
material price reference criterion at this time, and there is weak
evidence at best that it meets the material liquidity criterion, which
is not sufficient by itself to support a SPDC determination.
Accordingly, the Commission will issue the attached Order declaring
that the HIS contract is not a SPDC.
Issuance of this Order indicates that the Commission does not at
this time regard ICE as a registered entity in connection with its HIS
contract.\34\ Accordingly, with respect to its HIS contract ICE is not
required to comply with the obligations, requirements and timetables
prescribed in Commission rule 36.3(c)(4) for ECMs with SPDCs.
---------------------------------------------------------------------------
\34\ See 73 FR 75888, 75893 (Dec. 12, 2008).
---------------------------------------------------------------------------
c. The Henry Financial Swing (HHD) Contract and the SPDC Indicia
The ICE HHD contract is cash settled based on the spot index price
for natural gas at the Henry Hub on a specified day, as reported in the
``Daily Price Survey'' table of Platts' Gas Daily. The Platts index
price is based on fixed-price cash market transactions that are
voluntarily reported by traders. The size of the HHD contract is 2,500
mmBtu, and the unit of trading is any multiple of 2,500 mmBtu. The HHD
contract is listed for 65 consecutive calendar days.
Swing contracts are cash-settled natural gas contracts that specify
2,500 mmBtu of gas at a particular location on a specific day and is
settled using a price index published by a third-party price reporter.
The ICE HHD swing contract represents the spot price of natural gas at
the Henry Hub on a particular day. Swing contracts allow traders to
refine or lift hedges during the delivery month that were previously
established using the NYMEX Henry Hub natural gas futures contract.
Swing contracts are most useful after the NYMEX futures contract has
stopped trading, which is just prior to the beginning of the delivery
month. Physically-delivered and cash-settled transactions based on the
NYMEX Henry Hub price involves natural gas that is delivered over the
entire delivery month. If, for example, a firm's needs change and it no
longer needs all of the natural gas for which it hedged (say it now
requires only half of the originally hedged natural gas in the final
week of the delivery month), then the HHD contract can be used to
offset the part of the original hedge even though NYMEX futures
contract has ceased trading.
In its October 20, 2009, Federal Register notice, the Commission
identified material liquidity, arbitrage and material price reference
as the potential SPDC criteria applicable to the HHD contract. Each of
these criteria is discussed below.\35\
---------------------------------------------------------------------------
\35\ As noted above, the Commission did not find an indication
of price linkage in connection with this contract; accordingly, that
criterion is not discussed in reference to the HHD contract.
---------------------------------------------------------------------------
1. Material Price Reference Criterion
The Commission's October 20, 2009, Federal Register notice
identified material price reference as a potential basis for a SPDC
determination with respect to this contract. The Commission noted that
ICE sells its price data to market participants in a number of
different packages which vary in terms of the hubs covered, time
periods, and whether the data are daily only or historical. For
example, ICE offers ``Gulf Gas End of Day'' and ``OTC Gas End of Day''
\36\ with access to all price data or just current prices plus a
selected number of months (i.e., 12, 24, 36 or 48 months) of historical
data. These two packages include price data for the HHD contract.
---------------------------------------------------------------------------
\36\ The OTC Gas End of Day dataset includes daily settlement
prices for natural gas contracts listed for all points in North
America.
---------------------------------------------------------------------------
Although the Henry Hub is a major trading center for natural gas in
the United States and, as noted, ICE sells price information for the
HHD contract, the Commission has found upon further evaluation that the
HHD contract is not ``routinely consulted by industry participants in
pricing cash market transactions'' and thus does not meet the
Commission's guidance for the Material Price Reference criteria. In
this regard, the NYMEX Henry Hub futures contract is routinely
consulted by industry participants in pricing cash market transactions
at this location, because both the HHD and the NYMEX contracts
basically price the same commodity at the same location and the NYMEX
contract has significantly higher trading volume and open interest, it
is not necessary for market participants to independently refer to the
HHD contract for pricing natural gas at this location. Furthermore, the
Commission notes that publication of the HHD contract's prices is not
indirect evidence of routine dissemination. The HHD contract's prices
are published with those of numerous other contracts, which are of more
interest to market participants.\37\ The Commission cannot surmise
whether or not traders specifically purchase the ICE data packages for
the HHD contract's prices.
---------------------------------------------------------------------------
\37\ The Commission will rely on one of two sources of
evidence--direct or indirect--to determine a SPDC. Direct evidence
can be cash market transactions that are frequently based on or
quoted as a differential to the potential SPDC. Indirect evidence
includes contracts whose price series are routinely disseminated in
industry publications or are sold to market participants by the ECM.
---------------------------------------------------------------------------
i. Federal Register Comments
As noted above, ICE was the sole respondent which addressed the
question of whether the HHD contract is a SPDC. ICE stated in its
comment letter that the HHD contract does not meet the material price
reference criterion for SPDC determination. ICE stated that the
Commission appeared to base the case that the HHD contract is
potentially a SPDC on a disputable assertion. First, in issuing its
notice of intent to determine whether the HHD contract is a SPDC, the
CFTC cited a general conclusion in its ECM study ``that certain market
participants referred to ICE as a price discovery market for certain
natural gas contracts.'' ICE states that ``[b]asing a material price
reference determination on general statements made in a two year old
study does not seem to meet Congress' intent that the CFTC use its
considerable expertise to study the OTC markets.'' The Commission cited
the ECM study's general finding that some ICE natural gas contracts
appear to be regarded as price discovery markets as an indication that
an investigation of certain ICE contracts may be warranted; the ECM
study was not intended to serve as the sole basis for determining
whether or not a particular contract meets the material price reference
criterion.
ii. Conclusion Regarding Material Price Reference
The Commission finds that the HHD contract does not meet the
material price reference criterion because it is not routinely
consulted by cash market participants when pricing transactions at the
Henry Hub (direct evidence is not supported). Moreover, the ECM sells
the HHD contract's price data along with those of other contracts,
which are of more interest to market participants (indirect evidence is
not supported).
2. Arbitrage Criterion
In its October 20, 2009, Federal Register notice, the Commission
identified arbitrage as a potential basis
[[Page 23726]]
for a SPDC determination with respect to the HHD contract.
The Commission's Guidance (Appendix A to Part 36) notes that ``the
Commission will consider an arbitrage contract potentially to be a
[SPDC] * * * if, over the most recent quarter, greater than 95 percent
of the closing or settlement prices of the contract, which have been
calculated using transaction prices, fall within 2.5 percent of the
closing or settlement price of the contract or contracts which it could
be arbitraged.'' As noted above, the HHD contract is a daily contract
that reflects the spot price of natural gas at the Henry Hub and is
listed for 65 calendar days. In contrast, the NYMEX Henry Hub natural
gas futures contract is a pricing mechanism for natural gas in the
future. The NYMEX Henry Hub natural gas futures contract is available
for trading many months prior to the delivery period.
Arbitrage between the ICE HHD and NYMEX Henry Hub physically-
delivered natural gas futures contract potentially is possible.
However, the ability to arbitrage likely would be limited based on a
number of factors. First, the HHD contract prices the value of natural
gas on a single day while the NYMEX futures contract prices the value
of gas over a calendar month. Second, the futures contract and the HHD
contract are not always trading simultaneously. For example, the NYMEX
futures contract trades many years before delivery while the HHD
contract is listed out only 65 consecutive calendar days. Moreover, the
HHD contract trades into the delivery month while the NYMEX futures
contract stops trading three business days before the first business
day of the delivery month. Even during the times where the two
contracts are simultaneously traded, arbitrage between the two
contracts likely would involve multiple HHD contract to cover a period
of several days or weeks against a single NYMEX position, which would
be rather cumbersome and probably not practicable. Due to the
heterogeneous attributes of the two contracts, the test noted above to
determine the similarity of the two price series was not performed.
i. Federal Register Comments
As noted above, ICE was the sole respondent which addressed the
question of whether the HHD contract is a SPDC. ICE stated in its
comment letter that the HHD contract does not meet the arbitrage
criterion because it is a `` `decaying' product that expires daily
throughout its contract term. The HHD [contract] typically trades
`balance of month' therefore using multiple daily settlement prices. In
fact, the majority of HHD trades are intra-month after the * * * [NYMEX
Henry Hub natural gas futures contract] has already been priced.''
ii. Conclusion Regarding the Arbitrage Criterion
The HHD contract does not meet the arbitrage criterion because it
prices natural gas on a daily basis while the NYMEX futures contract
prices gas on a monthly basis. Moreover, the futures contract is used
to discover prices while the HHD contract is used to modify or lift
preexisting hedges.
3. Material Liquidity Criterion
As noted above, in its October 20, 2009, Federal Register notice,
the Commission identified material liquidity, arbitrage and material
price reference as potential criteria for SPDC determination of the HHD
contract. With respect to the material liquidity criterion, the
Commission noted that the total number of transactions executed on
ICE's electronic platform in the HHD contract was 5,246 in the second
quarter of 2009, resulting in a daily average of 82 trades. During the
same period, the HHD contract had a total trading volume of 242,968
contracts and an average daily trading volume of 3,796 contracts.
Moreover, open interest as of June 30, 2009, was 20,173 contracts,
which included trades executed on ICE's electronic trading platform, as
well as trades executed off of ICE's electronic trading platform and
then brought to ICE for clearing. In this regard, ICE does not
differentiate between open interest created by a transaction executed
on its trading platform and that created by a transaction executed off
its trading platform.\38\ In a subsequent filing dated November 13,
2009, ICE reported that total trading volume in the third quarter of
2009 was 407,037 contracts (or 6,167 contracts on a daily basis). In
term of number of transactions, 10,376 trades occurred in the third
quarter of 2009 (157.2 trades per day). As of September 30, 2009, open
interest in the HHD contract was 25,418 contracts, which included
trades executed on ICE's electronic trading platform, as well as trades
executed off of ICE's electronic trading platform and then brought to
ICE for clearing.
---------------------------------------------------------------------------
\38\ 74 FR 53720 (October 20, 2009).
---------------------------------------------------------------------------
The Commission notes that trading activity in the HHD contract
increased between the second and third quarters of 2009. Moreover, the
number of trades per day was quite large and was significantly greater
than the reporting level of five trades per day. Furthermore, the
number of contracts traded is comparable to the levels experienced in a
moderately active futures market, such as the ICE US Cotton No. 2
contract. Accordingly, the transaction data provide evidence that the
HHD contract may meet the material liquidity criterion.\39\
---------------------------------------------------------------------------
\39\ In establishing guidance to illustrate how it will evaluate
the various criteria, or combinations of criteria, when determining
whether a contract is a SPDC, the Commission made clear that
``material liquidity itself would not be sufficient to make a
determination that a contract is a [SPDC], * * * but combined with
other factors it can serve as a guidepost indicating which contracts
are functioning as [SPDCs].'' For the reasons discussed above, the
Commission has found that the HEN contract does not meet either the
price linkage or material price reference criterion. In light of
this finding and the Commission's Guidance cited above, there is no
need to evaluate further the material liquidity criteria since it
cannot be used alone as a basis for a SPDC determination.
---------------------------------------------------------------------------
i. Federal Register Comments
As noted above, ICE was the sole respondent which addressed the
question of whether the HHD contract is a SPDC. ICE stated in its
comment letter that the HHD contract does not meet the material
liquidity criterion for SPDC determination for a number of reasons.
First, ICE opined that the Commission ``seems to have adopted a
five trade-per-day test to determine whether a contract is materially
liquid. It is worth noting that ICE originally suggested that the CFTC
use a five trades-per-day threshold as the basis for an ECM to report
trade data to the CFTC.'' On the contrary, the Commission adopted a
five trades-per-day threshold as a reporting requirement to enable it
to ``independently be aware of ECM contracts that may develop into
SPDCs'' \40\ rather than solely relying upon an ECM on its own to
identify any such potential SPDCs to the Commission. While a contract
that meets this threshold may be subject to scrutiny as a potential
SPDC, the threshold is not a test for material liquidity. As noted
above, the Commission has not reached a decision regarding material
liquidity because, regardless of the relatively large number of trades
per day and the large quarterly trading volume in the HHD contract,
material liquidity alone is not sufficient to support a SPDC
determination.
---------------------------------------------------------------------------
\40\ 73 FR 75892 (December 12, 2008).
---------------------------------------------------------------------------
ICE also stated that ``the statistics [provided by ICE] have been
misinterpreted and misapplied.'' In particular, ICE stated that the
volume figures used in the Commission's analysis (cited above)
``include trades made in all 120 months of each contract'' as well as
in strips of contract
[[Page 23727]]
months, and a ``more appropriate method of determining liquidity is to
examine the activity in a single traded month or strip of a given
contract.'' Furthermore, ICE noted that for the HHD contract, ``78% of
the total volume was actually executed on the ICE platform in the
single most liquid, usually prompt, month of the contract.''
It is the Commission's opinion that liquidity, with regard to the
HHD contract, is typically a function of trading activity in particular
lead months and, given sufficient liquidity in such months, the HHD
contract itself would be considered liquid. ICE's analysis of its own
trade data confirms this to be the case for the HHD contract, and thus,
the Commission believes that it applied the statistical data cited
above in an appropriate manner for gauging material liquidity.
In addition, ICE stated that the trades-per-day statistics that it
provided to the Commission in its quarterly filing and which are cited
above includes 2(h)(1) transactions, which were not completed on the
electronic trading platform and should not be considered in the SPDC
determination process. Commission staff asked ICE to review the data it
sent in its quarterly filings and ICE confirmed that the volume data it
provided and which the Commission cited in its October 20, 2009,
Federal Register notice as well as the additional volume information it
cites above includes only transaction data executed on ICE's electronic
trading platform.\41\ The Commission acknowledges that the open
interest information it cites above includes transactions made off the
ICE platform. However, once open interest is created, there is no way
for ICE to differentiate between ``on-exchange'' versus ``off-
exchange'' created positions, and all such positions are fungible with
one another and may be offset in any way agreeable to the position
holder regardless of how the position was initially created.
---------------------------------------------------------------------------
\41\ Supplemental data supplied by ICE confirmed that block
trades in the third quarter of 2009 were in addition to the trades
that were conducted on the electronic platform; block trades
comprised 1.2 percent of all transactions in the HHD contract.
---------------------------------------------------------------------------
ii. Conclusion Regarding Material Liquidity
For the reasons discussed above, the Commission finds that the HHD
contract may meet the material liquidity criterion. However, because
the HHD contract does not meet the material price reference or the
arbitrage criterion, it is not possible to declare the HHD contract a
SPDC since material liquidity cannot be used alone as a basis for SPDC
determination.
4. Overall Conclusion
After considering the entire record in this matter, including the
comments received, the Commission has determined that the HHD contract
does not perform a significant price discovery function under the
criteria established in section 2(h)(7) of the CEA. Specifically, the
Commission has determined that the HHD contract does not meet the
material price reference and arbitrage criteria at this time nor is
material liquidity sufficient by itself to support a SPDC
determination. Accordingly, the Commission will issue the attached
Order declaring that the HHD contract is not a SPDC.
Issuance of this Order indicates that the Commission does not at
this time regard ICE as a registered entity in connection with its HHD
contract.\42\ Accordingly, with respect to its HHD contract ICE is not
required to comply with the obligations, requirements and timetables
prescribed in Commission rule 36.3(c)(4) for ECMs with SPDCs.
---------------------------------------------------------------------------
\42\ See 73 FR 75888, 75893 (Dec. 12, 2008).
---------------------------------------------------------------------------
V. Related Matters
a. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (``PRA'') \43\ imposes certain
requirements on Federal agencies, including the Commission, in
connection with their conducting or sponsoring any collection of
information as defined by the PRA. Certain provisions of Commission
rule 36.3 impose new regulatory and reporting requirements on ECMs,
resulting in information collection requirements within the meaning of
the PRA. OMB previously has approved and assigned OMB control number
3038-0060 to this collection of information.
---------------------------------------------------------------------------
\43\ 44 U.S.C. 3507(d).
---------------------------------------------------------------------------
b. Cost-Benefit Analysis
Section 15(a) of the CEA \44\ requires the Commission to consider
the costs and benefits of its actions before issuing an order under the
Act. By its terms, section 15(a) does not require the Commission to
quantify the costs and benefits of an order or to determine whether the
benefits of the order outweigh its costs; rather, it requires that the
Commission ``consider'' the costs and benefits of its actions. Section
15(a) further specifies that the costs and benefits shall be evaluated
in light of five broad areas of market and public concern: (1)
Protection of market participants and the public; (2) efficiency,
competitiveness and financial integrity of futures markets; (3) price
discovery; (4) sound risk management practices; and (5) other public
interest considerations. The Commission may in its discretion give
greater weight to any one of the five enumerated areas and could in its
discretion determine that, notwithstanding its costs, a particular
order is necessary or appropriate to protect the public interest or to
effectuate any of the provisions or accomplish any of the purposes of
the Act.
---------------------------------------------------------------------------
\44\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------
When a futures contract begins to serve a significant price
discovery function, that contract, and the ECM on which it is traded,
warrants increased oversight to deter and prevent price manipulation or
other disruptions to market integrity, both on the ECM itself and in
any related futures contracts trading on DCMs. An Order finding that a
particular contract is a SPDC triggers this increased oversight and
imposes obligations on the ECM calculated to accomplish this goal. The
increased oversight engendered by the issue of a SPDC Order increases
transparency and helps to ensure fair competition among ECMs and DCMs
trading similar products and competing for the same business. Moreover,
the ECM on which the SPDC is traded must assume, with respect to that
contract, all the responsibilities and obligations of a registered
entity under the CEA and Commission regulations. Additionally, the ECM
must comply with nine core principles established by section 2(h)(7) of
the Act--including the obligation to establish position limits and/or
accountability standards for the SPDC. Section 4(i) of the CEA
authorize the Commission to require reports for SPDCs listed on ECMs.
These increased responsibilities, along with the CFTC's increased
regulatory authority, subject the ECM's risk management practices to
the Commission's supervision and oversight and generally enhance the
financial integrity of the markets.
The Commission has concluded that ICE's HEN, HIS and HHD contracts
that are the subject of the attached Orders are not SPDCs; accordingly,
the Commission's Orders impose no additional costs and no additional
statutorily or regulatory mandated responsibilities on the ECM.
c. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') \45\ requires that
agencies consider the impact of their rules on small businesses. The
requirements of CEA section 2(h)(7) and the Part 36 rules affect ECMs.
The Commission previously has determined that ECMs
[[Page 23728]]
are not small entities for purposes of the RFA.\46\ Accordingly, the
Chairman, on behalf of the Commission, hereby certifies pursuant to 5
U.S.C. 605(b) that these Orders, taken in connection with section
2(h)(7) of the Act and the Part 36 rules, will not have a significant
impact on a substantial number of small entities.
---------------------------------------------------------------------------
\45\ 5 U.S.C. 601 et seq.
\46\ 66 FR 42256, 42268 (Aug. 10, 2001).
---------------------------------------------------------------------------
VI. Orders
a. Order Relating to the ICE Henry Financial Basis Contract
After considering the complete record in this matter, including the
comment letters received in response to its request for comments, the
Commission has determined to issue the following:
The Commission, pursuant to its authority under section 2(h)(7) of
the Act, hereby determines that the Henry Financial Basis contract,
traded on the IntercontinentalExchange, Inc., does not at this time
satisfy the material price reference and price linkage criteria for
significant price discovery contracts. Moreover, under Commission
Guidance material liquidity alone cannot support a significant price
discovery finding for the Henry Financial Basis contract. Consistent
with this determination, the IntercontinentalExchange, Inc., is not
considered a registered entity \47\ with respect to the Henry Financial
Basis contract and is not subject to the provisions of the Commodity
Exchange Act applicable to registered entities. Further, the
obligations, requirements and timetables prescribed in Commission rule
36.3(c)(4) governing core principle compliance by the
IntercontinentalExchange, Inc., are not applicable to the Henry
Financial Basis contract with the issuance of this Order.
---------------------------------------------------------------------------
\47\ 7 U.S.C. 1a(29).
---------------------------------------------------------------------------
This Order is based on the representations made to the Commission
by the IntercontinentalExchange, Inc., dated July 27, 2009, and
November 13, 2009, and other supporting material. Any material change
or omissions in the facts and circumstances pursuant to which this
order is granted might require the Commission to reconsider its current
determination that the Henry Financial Basis contract is not a
significant price discovery contract. Additionally, to the extent that
it continues to rely upon the exemption in Section 2(h)(3) of the Act,
the IntercontinentalExchange, Inc., must continue to comply with all of
the applicable requirements of Section 2(h)(3) and Commission
Regulation 36.3.
b. Order Relating to the ICE Henry Financial Index Contract
After considering the complete record in this matter, including the
comment letters received in response to its request for comments, the
Commission has determined to issue the following:
The Commission, pursuant to its authority under section 2(h)(7) of
the Act, hereby determines that the Henry Financial Index contract,
traded on the IntercontinentalExchange, Inc., does not at this time
satisfy the material price reference criterion for significant price
discovery contracts. Moreover, under Commission Guidance material
liquidity alone cannot support a significant price discovery finding
for the Henry Financial Index contract. Consistent with this
determination, the IntercontinentalExchange, Inc., is not considered a
registered entity \48\ with respect to the Henry Financial Index
contract and is not subject to the provisions of the Commodity Exchange
Act applicable to registered entities. Further, the obligations,
requirements and timetables prescribed in Commission rule 36.3(c)(4)
governing core principle compliance by the IntercontinentalExchange,
Inc., are not applicable to the Henry Financial Index contract with the
issuance of this Order.
---------------------------------------------------------------------------
\48\ 7 U.S.C. 1a(29).
---------------------------------------------------------------------------
This Order is based on the representations made to the Commission
by the IntercontinentalExchange, Inc., dated July 27, 2009, and
November 13, 2009, and other supporting material. Any material change
or omissions in the facts and circumstances pursuant to which this
order is granted might require the Commission to reconsider its current
determination that the Henry Financial Index contract is not a
significant price discovery contract. Additionally, to the extent that
it continues to rely upon the exemption in Section 2(h)(3) of the Act,
the IntercontinentalExchange, Inc., must continue to comply with all of
the applicable requirements of Section 2(h)(3) and Commission
Regulation 36.3.
c. Order Relating to the ICE Henry Financial Swing Contract
After considering the complete record in this matter, including the
comment letters received in response to its request for comments, the
Commission has determined to issue the following:
The Commission, pursuant to its authority under section 2(h)(7) of
the Act, hereby determines that the Henry Financial Swing contract,
traded on the IntercontinentalExchange, Inc., does not at this time
satisfy the material price reference and arbitrage criteria for
significant price discovery contracts. Moreover, under Commission
Guidance material liquidity alone cannot support a significant price
discovery finding for the Henry Financial Swing contract. Consistent
with this determination, the IntercontinentalExchange, Inc., is not
considered a registered entity \49\ with respect to the Henry Financial
Swing contract and is not subject to the provisions of the Commodity
Exchange Act applicable to registered entities. Further, the
obligations, requirements and timetables prescribed in Commission rule
36.3(c)(4) governing core principle compliance by the
IntercontinentalExchange, Inc., are not applicable to the Henry
Financial Swing contract with the issuance of this Order.
---------------------------------------------------------------------------
\49\ 7 U.S.C. 1a(29).
---------------------------------------------------------------------------
This Order is based on the representations made to the Commission
by the IntercontinentalExchange, Inc., dated July 27, 2009, and
November 13, 2009, and other supporting material. Any material change
or omissions in the facts and circumstances pursuant to which this
order is granted might require the Commission to reconsider its current
determination that the Henry Financial Swing contract is not a
significant price discovery contract. Additionally, to the extent that
it continues to rely upon the exemption in Section 2(h)(3) of the Act,
the IntercontinentalExchange, Inc., must continue to comply with all of
the applicable requirements of Section 2(h)(3) and Commission
Regulation 36.3.
Issued in Washington, DC on April 28, 2010, by the Commission.
David A. Stawick,
Secretary of the Commission.
[FR Doc. 2010-10313 Filed 5-3-10; 8:45 am]
BILLING CODE P